The Big Six banks set aside $2.5 billion for credit and loan losses
Canada’s six largest banks have put aside a combined total of more than $2.4 billion to prepare for a wave of credit and loan losses. More Canadians will be unable to pay off loans and credit card debt as the country heads into a potential recession.
The Big Six banks, which reported fiscal first-quarter earnings over the past week, all posted significant increases in such reserves — called provisions for credit losses (PCLs) .
“Unfortunately some people can’t repay loans that they have taken out,” said Laurence Booth, a professor of finance at the University of Toronto’s Rotman School of Management. “This happens regularly but it tends to spike when we go into recession and people lose their major source of income, such as their employment or small business income. “
The $2.49 billion in reserves were outlined in recent first quarter results posted by Canada’s six largest banks: the Royal Bank of Canada, TD Bank, Scotiabank, BMO, CIBC and National Bank.
It’s the biggest buffer for credit losses since the first year of the pandemic, when the financial giants also built up provisions before it became clear that government financial supports and a stockpile of consumer savings would help stave off a wave of loan delinquencies.
But Canadians are now grappling with sharply higher borrowing costs, after a year of aggressive interest-rate hikes by the central bank, and facing still-persistently high prices for food and other necessities.
Bank executives said they don’t expect a dramatic spike in defaults, particularly as employment remains high, but they anticipate what they call a “normalization” of credit loss trends.
They said the risks of delinquencies and losses on credit cards, lines of credit and auto loans are more likely than mortgage defaults, and such delinquencies have already started to increase in recent quarters.
“We expect write offs and delinquencies to revert towards pre-pandemic levels,” said CIBC’s Chief Risk Officer Frank Guse, while executives from the other banks shared similar comments.
“As anticipated, key credit metrics continued to rise from cyclically low levels experienced last year,” said Ajai Bambawale, chief risk officer at TD, “with this trend most evident in the consumer lending portfolios.”
Royal Bank CEO Dave McKay said Wednesday that his bank’s financial results were hit by higher PCLs in the quarter, noting, “we expect them to continue increasing from cyclical lows.”
The country’s biggest bank set aside $532 million in PCLs for the three months ended Jan. 31, up from $105 million in the same period last year, and McKay added that the growing cost of debt will play a role in the broader economic picture.
This marks a significant increase from the $373 million the six banks allocated for PCLs a year ago, during the first quarter of 2022. Around the same time in March 2022, the Bank of Canada began its attempt to tame inflation by hiking the interest rates, which climbed from a historic low of 0.25 per cent to 4.5 per cent today – the highest it’s been since 2007.
“Currently with the Bank of Canada pushing up short-term interest rates to slow down the economy, and bring inflation down, the expectation is for a recession in Q2 or Q3 this year,” Booth explained. “Consequently, the banks are making provisions for potential losses should a recession occur.”
In recent Q1 earnings conference calls, bank executives said high employment and savings should help avert a large increase in payment defaults, which fell during the pandemic. Rather, they widely expected a “normalization” driven by interest rate hikes and inflation, with loans and credit card debt expected to be the most impacted.
“Current underlying conditions, particularly the strong level of employment and consumer savings, are supporting a slower rate of normalization of impaired PCLs than we had expected,” National Bank executive vice-president of risk management William Bonnell said during a March 1 earnings call. “The same factors we discussed last year – inflationary pressures, geopolitical risks, and the direction and timing of interest rate changes – are still present and all contribute to a less certain outlook.”
The Royal Bank of Canada, the country’s largest bank, held its earnings call the same day.
“Our PCL ratio on impaired loans remains below pre-pandemic levels, but we have seen the normalization of delinquencies and impairments, as higher interest rates start to impact credit outcomes,” RBC chief risk officer Graeme Hepworth said. “We expect PCL on impaired loans to increase through 2023, as we head into a forecasted recession.”
Similar sentiments were expressed by Canada’s other leading financial institutions, including the Bank of Montreal.
“The quarter-over-quarter increase in impaired PCL is consistent with the expected normalization trend in delinquency rates in unsecured consumer loans and credit cards, which still remain below pre-pandemic levels,” BMO chief risk officer Piyush Agrawal said on a Feb. 28 earnings call.
Claire Celerier, an associate professor of finance at the Rotman School of Management, says while those with variable rate mortgages may be feeling the most immediate pain from high interest rates, those on fixed-terms will be affected when their mortgages renew. Celerier also thinks high provisions for credit losses will make it even harder for Canadians to secure loans.
“When banks make provisions for losses, it affects their ratio of equity to assets,” Celerier said. “This ratio will decrease, which affects bank lending. This might contribute to a decrease in lending in the coming months.”
Scotiabank Chief Risk Officer Phil Thomas said consumers are already spending less on travel and dining out, though the savings have been partially offset by higher grocery expenses.
“We know that our customers are responding to a higher cost of living by making trade-offs to manage their spending habits.”
Still, Scotia’s Thomas said, “the low level of unemployment across most of our core geographies is a driving factor for the stability of household incomes despite inflationary pressures.”
The banks said strong employment numbers, wage growth and savings mean many of their mortgage clients are well positioned to avoid defaults and noted that mortgage delinquency rates remain low.
This article was reported by CTV News and the Star.